How to Use this Less Risky Investment Alternative

by George Leong, B. Comm.

For some of you, there are alternatives to buying stocks if you are longer-term bullish on a company but are concerned with the short-term volatility and risk.

Those of you who trade options are probably aware of the concept of LEAPS or Long-Term Equity Anticipation Securities. LEAPS represent a long-term trade on a stock that allows the trade time to pan out.

The LEAPS are divided into both call or put options on the underlying stock and each is characterized by a time to expiry of more than nine months to three years from the time of the initial purchase.

But LEAPS are different from your typical shorter-term options. LEAPS have five distinct features: more expensive; less speculative; time is not a major factor; and lower risk/lower return. So while shorter-term options are generally advised only for aggressive traders, LEAPS are generally more conservative since the window of opportunity is longer. For the more conservative investors or option traders, LEAPS provide an excellent alternative to a “buy and hold” strategy because of the leverage involved, as well as the management of risk.

The correlation between LEAPS and the underlying stock and the fact that they have a long shelf life makes them an increasingly attractive vehicle for the more conservative investor.

In general, a LEAPS call (put) option on stocks will move up (down) dollar-for-dollar with the underlying stock above (below)
the breakeven point.

As an investor, LEAPS could be used in many scenarios. What if you feel the current bear market is set to reverse, but are not sure when?

So what do you do? Do you buy stocks now and hope your prognosis on the market is correct? But if you guess wrong, you could be in line for additional losses in your trading account. Perhaps you should sit idly aside, but then you may miss out on opportunities.

Let’s say you’re short-term bearish, but long-term bullish on stocks. Under this set of assumptions, buying options with a longer time frame may make some sense. It also makes sense if you’re short of funds because of past losses, but don’t want to miss out on a potential market reversal.

This same logic applies to those with a bearish viewpoint, who can purchase LEAPS puts to bet on a downside move. The mechanics of LEAPS puts are the same as the normal puts, but with an extended expiry.

And similar to normal options, you can also write covered and naked LEAPS calls and puts. The underlying mechanics are identical, with the exception of the extended expiration date. You will also realize that you can use LEAPS in many more complex strategies just like normal options, such as spreads and combinations. You are only confined by your trading creativity.

Whatever may be the case; you should take a look at LEAPS as a viable investment alterative to a buy-and-hold strategy. The maximum risk from LEAPS is set and you know what you could lose; whereas, when buying the stock, the loss could be much greater if you make an incorrect call.